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Mainland slows down forex buying

With slowing capital inflows and companies retaining their foreign currencies, the central bank faces limited options to boost yuan supply

PUBLISHED : Friday, 24 August, 2012, 12:00am
UPDATED : Friday, 24 August, 2012, 3:37am

Foreign exchange accumulation on the mainland decelerated drastically this year, limiting the central bank's alternatives in boosting money supply.

The People's Bank of China's purchases of foreign exchange totalled 298.8 billion yuan (HK$365.79 billion) in the first seven months of the year, a year-on-year slump of 87 per cent, it said.

Mopping up foreign exchange earned by companies and individuals and releasing yuan into the system in return has been the most important tool used by the central bank to maintain yuan supply.

In the first seven months, the ratio of outstanding foreign exchange to broad money supply M2 fell to 28 per cent from 32 per cent a year ago.

The country's slowing trade surplus, foreign direct investment and other capital inflows are the main reasons behind the slower pace of foreign exchange build-up in the banking system as external demand slackened amid the European debt crisis and foreign investors started to pull back from China amid signs of cooling in the economy.

Meanwhile, companies and individuals have been choosing to hold on to their foreign currencies instead of converting them into the yuan as the outlook for yuan appreciation has dimmed. The total amount of foreign-currency deposits by non-financial companies and individuals on the mainland grew US$266.3 billion in the January-July period, marking a 12-fold increase over the same period last year.

"Changes in foreign-exchange holdings are having a tightening rather than an expansionary effect in corporate funding and monetary and credit environments," China International Capital Corp economist Peng Wensheng said. "And this will become a trend."

Foreign-exchange purchases began to slow significantly in October, and turned negative that month, as well as in November, December, April and July, according to the PBOC.

Zhang Monan, a researcher at the Beijing-based think-tank State Information Centre, said the long-term trend would be a slowdown in foreign-exchange inflows as economic growth on the mainland decelerated and the one-way bet on yuan appreciation became a thing of the past.

"With the private sector holding more assets in foreign currencies, the central bank has been passive in mopping up yuan, leading to a tightening in RMB supplies."

Many economists say China needs monetary easing after growth cooled to 7.6 per cent in the second half, a three-year low. They expect further loosening as July's data showed no sign of a turnaround. The central bank has already cut banks' required reserve ratio three times since November and interest rates in June and July.

UBS Securities economist Wang Tao said: "This year we'll see smaller foreign-exchange inflows. However, even if foreign exchange inflows shrink sharply because of a lower trade surplus and capital outflows, the central bank would still have plenty of ways to increase base money supply - through reverse repurchases and cuts in required reserve ratio."

In a reverse repurchase, a central bank buys bonds from banks to increase liquidity for a short period, and sells them back later.

A reduction in the reserve ratio is widely expected this month after July data indicated the economy was losing steam, but no cut has been announced yet.

The central bank announced a 220 billion yuan reverse repurchase on Tuesday to boost liquidity. This was the ninth consecutive week it used the tool in open-market operations, the longest period since June 2002.

Academics said the PBOC was likely to rely on such bond transactions, either directly or through repurchase contracts as a monetary tool in the future, replacing the role of foreign exchange purchases in money supply.

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